   Chapter 16, Problem 7PA

Chapter
Section
Textbook Problem

Suppose economists observe that an increase in government spending of $10 billion raises the total demand for goods and services by$30 billion.a. If these economists ignore the possibility of crowding out, what would they estimate the marginal propensity to consume (MPC) to be?b. Now suppose the economists allow for crowding out. Would their new estimate of the MPC be larger or smaller than their initial one?

Subpart (a):

To determine

Marginal propensity to consume.

Explanation

When there is no crowding out effect, the multiplier is calculated using the following equation:

Multiplier=11MPC (1)

Since the multiplier is 3, the marginal propensity to consume is calculated using equation 1, as follows:

1MPC=1Multiplier

Subpart (b):

To determine

Marginal propensity to consume.

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